Inforuptcy Blog Categories: Buying assets 101

INTRODUCTION
One of the most controversial bankruptcy court cases of the past year was Fisker Automotive Holdings, Inc. (“Fisker”) decided in Delaware. Many investors have feared the Fisker decision would forever change the market for the strategic acquisition of secured debt. However, Fisker should only be read in the context of the particular facts and circumstances of that case. Bankruptcy Courts always had, and will continue to have, the power to restrict credit bids for cause under section 363(k) of the Bankruptcy Code, if the facts and circumstances warrant such limitation. In Fisker, the Bankruptcy Court limited the secured creditor’s ability to credit bid for several reasons – its liens did not encompass all assets for sale, the expedited sale process, collusion, and possibly inequitable conduct – which all may constitute “cause” under
363(k).

CREDIT BIDDING
As you learned from prior blog articles, credit bidding is the right of a secured creditor to bid the value of its claim in a bankruptcy sale. Such credit bidding allows secured creditors to control the sale of their collateral. Thus, when collateral secured by a lien is proposed to be sold at a bankruptcy auction, the secured creditor or creditors have the right to bid the amount of their debt as a credit bid, as opposed to being limited to a cash bid. This allows secured creditors to compete with cash bidders who are interested in obtaining their collateral.

The ability to credit bid has been a driving factor in the market for the acquisition of secured debt, often purchased at a discount. Parties interested in obtaining certain
assets can strategically purchase the secured debt from the current lender or debt holder which would allow the purchaser to exercise all the rights the original secured creditor had. As a purchaser of secured debt, it is very important to conduct due diligence and to confirm that the liens encumber all the assets the liens purport to encumber, have been properly perfected in accordance with applicable law and that the liens are senior to any other debt on the assets and therefore must be paid first.

FISKER AUTOMOTIVE
By way of background, Fisker, and its affiliates, made premium hybrid electric vehicles in the United States. In 2011, the United States Department of Energy (the “DOE”) advised them it would cease funding and not permit further disbursements under its $168.5 million senior secured loan facility. In October 2013, Hybrid Tech Holdings, LLC (“Hybrid”) bought at auction the DOE’s $168.5 million loan for $25 million. Shortly thereafter, Hybrid and the Fisker entities entered into an asset purchase agreement for the private sale of substantially all of the Fisker assets to Hybrid for $75 million in the form of a credit bid.

On November 22, 2013, Fisker and its affiliates, filed chapter 11 and requested
court approval to sell substantially all of their assets to Hybrid on an expedited basis and without an auction process. The Creditors’ Committee (“Committee”) opposed the sale and Hybrid’s right to credit bid or, alternatively, to limit the credit bid at $25 million. Another bidder – Wanxiang America Corp. - was prepared to offer a higher bid at auction.

At the sale hearing, the Committee and Fisker stipulated to several issues, including: (i) a competitive auction would take place if Hybrid’s right to credit bid was limited and it was highly unlikely an auction would take place if Hybrid were allowed to credit bid the full amount of its claim; (b) limiting Hybrid’s ability to credit bid would foster and facilitate competitive bidding; and (c) certain assets to be sold were not encumbered by Hybrid’s liens and the validity of Hybrid’s liens on other assets was in dispute.

The Bankruptcy Court
concluded that although Hybrid could credit bid its claim such credit bid amount would be capped at $25 million. The Bankruptcy Court held that “cause” existed to limit Hybrid’s credit bid because bidding would be frozen without the cap; another attractive bidder was ready, willing and able to purchase the assets; and not only was the expedited timeframe unjustified but the validity of Hybrid’s secured status had not been determined. As a result, the Bankruptcy Court limited for cause Hybrid’s credit bid to $25 million without justifying why it chose to limit the amount to the $25 million.

SIGNIFICANCE OF FISKER
The significance of Fisker should be limited. Fisker is a fact specific case and should not be read to limit an investor’s ability to credit bid when it purchases secured debt at a discount. Further, until Hybrid’s appeal is decided or other courts rule on the issues, it is difficult to say with any certainty what effect, if any, the Fisker case will have on future credit bidding by a purchaser of secured debt. The objections raised in Fisker could be raised in any bankruptcy sale context which includes a collusive, expedited, private sale process with a credit bid by a creditor whose lien is not secured against all of the assets.

While the bankruptcy court limited Hybrid’s credit bid to the price it paid for the
debt secured by certain of the debtor’s assets, in many instances no parties in a bankruptcy case would even know what the investor paid for the debt. Such information is rarely disclosed absent a court order compelling disclosure.

CONCLUSION
The significance and effect Fisker should have on the distressed sales market is to stress the importance of pre-purchase planning. Any investor seeking to purchase secured debt should perform its due diligence, in consultation with experienced bankruptcy counsel, to develop a plan to try to minimize the potential application of Fisker or any issue which could constitute cause under section 363(k) of the Bankruptcy Code, such as understanding the scope of collateral securing debt and not trying to force an expedited sale process which may only offend the court and other creditors.

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Deborah J. Piazza, Esq. is a Partner in the Bankruptcy and Corporate Restructuring Group at Tarter Krinsky & Drogin LLP. She handles transactional, litigation and advisory work relating to various types of restructurings, commercial finance, bankruptcies and workouts. She also sits on the panel of chapter 7 trustees in the Southern District of New York. Tarter Krinsky & Drogin LLP is a general practice law firm with in-depth expertise in every area of law including, but not limited to, real estate, litigation, finance, intellectual property, corporate, construction, tax, employment and ERISA with offices in New York City and New Jersey.

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INTRODUCTION
A creditor with a lien against property subject to a sale under the Bankruptcy Code generally is entitled to bid the value of its claim. This avenue for lenders to recover on their collateral may also be an opportunity for distressed asset investors. Looking for a market advantage, investors may seek to acquire loans and the associated liens with an eye toward foreclosure or the acquisition of the property outright through a section 363 sale. The credit bid is an attractive option to the purchaser who may have acquired the underlying loan rights at a steep discount. However, such a venture will not always be welcome by the trustee or debtor seeking to maximize the recovery from the sale of an estate asset.

THE STATUTE
11 U.S.C. § 363(k) provides as follows:

At a sale under subsection (b) of this section of property that is subject to a lien that secures an allowed claim, unless the court for cause orders otherwise the holder of such claim may bid at such sale, and, if the holder of such claim purchases such property, such holder may offset such claim against the purchase price of such property.

This provision warrants some unpacking. While the right to credit
bid is an important right to creditors, this right is by no means absolute, as the bankruptcy court may “for cause” deny the right to credit bid.

THRESHOLD ISSUES
As a threshold matter, a party seeking to credit bid must have a valid secured claim. If the secured claim is subject to dispute at the time of the sale under section 363, the bankruptcy court may not allow the creditor to credit bid, or may allow the creditor to credit bid provisionally, requiring the creditor to pay in cash if the claim is reduced or the lien is invalidated.[1]

Another barrier to credit bidding is lien seniority. A junior lienholder may be barred from credit bidding where the collateral is so far underwater that the lien itself has no value.[2]

When such issues are overcome, there are yet other reasons, having more to do
with the equities and the economics of the particular sale and case, that may constitute cause to deny the right to credit bid.

RadLAX
There is a line of cases in which the trustee or debtor-in-possession seeks to sell property without credit bidding. The most recent Supreme Court decision on the issue is RadLAX Gateway Hotel, LLC v. Amalgamated Bank, 132 S. Ct. 2065 (2012). The debtors in RadLAX
purchased the Radisson Hotel at the Los Angeles International Airport in 2007. The debtors owed the bank $120 million when they filed for chapter 11 protection in 2009. The debtors proposed a chapter 11 plan which contemplated sale of the property, and which would require the bank to bid in cash. The bank objected. Turning to the “cramdown” provisions of section 1129(b), under which a debtor may confirm a plan over creditors’ objections, the Court determined that the denial of the right to credit bid was impermissible under the circumstances. Section 1129(b)(2)(A)(ii) provides:

For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:

(A)With respect to a class of secured claims, the plan provides—…

(ii) for the sale, subject to section 363…(k) of this title, of any property that is subject to the liens securing such claims, free and clear of such liens, with such liens to attach to the proceeds of such sale, and the treatment of such liens on proceeds under clause (i) or (iii) of this subparagraph.

The debtors argued that they need not satisfy 1129(b)(2)(A)(ii) because they satisfied 1129(b)(2)(A)(iii), which provides:

(A)With respect to a class of secured claims, the plan provides—…

(iii)for the realization by such holders of the indubitable equivalent of such
claims.

The debtors reasoned that by paying the bank from sale proceeds, the debtors would be giving the bank the “indubitable equivalent” of its secured claim. The Court rejected this argument based on a basic canon of statutory interpretation—“that the specific governs the general.” Since (A)(ii) is specific to sales, it governs. In a footnote, the Court mentioned that that the bankruptcy court had found that there was no “cause” to deny credit bidding under section 363(k).[3]

“CAUSE” TO DENY THE RIGHT TO CREDIT BID
“Cause” to deny the right to credit bid is not defined in the Bankruptcy Code. Besides the circumstances concerning the validity or value of the lien addressed above, Courts have generally found “cause” to exist where denial is “in the interest of any policy advanced by the Code, such as to ensure the success of the reorganization or to foster a competitive bidding environment.”[4] A finding that a party has engaged in misconduct vis-à-vis the estate may be cause to deny the right to credit bid.[5] Beyond such examples, courts have found that the chilling of bidding can constitute cause.[6] The court in Fisker Automotive Holdings
denied credit bidding because, under the circumstances, it determined that credit bidding would have made an auction essentially impossible.[7] These issues will be discussed at greater length in a future Inforuptcy blog post. It is sufficient for our purposes to conclude that, notwithstanding the generally accepted importance of the right to credit bid,[8] “cause” can be a fairly broad concept limiting, or eliminating, the right in many cases.

THE “FULL CREDIT BID”
As a final consideration in this overview, it must be noted that the concept of credit bidding is enshrined under nonbankruptcy law.[9] Under nonbankruptcy law, the “full credit bid” (that is an amount equal to the unpaid principal, interest and foreclosure expense) has the effect of extinguishing the creditor’s rights and remedies, including against guarantors and insurers. Thus, it should be exercised with caution.[10]

CONCLUSION
The credit bid in bankruptcy is a potentially powerful tool and valuable asset to creditors and distressed property investors. It must however be approached and exercised with knowledge of the potential pitfalls.

As a general rule, trustees do not sell underwater properties. If the property is fully encumbered by liens, there is no equity available to benefit the bankruptcy estate, and thus the trustee should not liquidate the property.[1] Like many good rules, this one has its exceptions. If selling the property will benefit the estate, and the lien holder consents to the sale, the property may be sold under 11 U.S.C. § 363. Enter the “carveout.” A carveout agreement, in this context, is one by which a lien holder subordinates its secured
claim, thereby making it possible for the trustee to liquidate the asset.[2]

One prime example of this kind of carveout involves a secured claim holder whose lien is secured by overencumbered real property. Outside of bankruptcy, or if granted relief from the automatic stay pursuant to 11 U.S.C. § 362, such lien holder would seek to foreclose on the property. Instead of seeking relief from the automatic stay to then proceed with foreclosure under nonbankruptcy law, the lien holder negotiates a carveout agreement with the trustee thereby allowing the trustee to sell the property under 11 U.S.C. § 363, amounting to a shortsale of the property. The specific terms can be negotiated, but whether they involve payment of a sum certain to the estate or payment in
full of administrative expenses with a dividend to unsecured creditors, the basic concept is that funds that would otherwise need to be paid to the secured creditor will instead be paid to the estate by virtue of the carveout agreement.

A challenge to such an arrangement may arise when the debtor claims an exemption in the proceeds of the sale. State exemption laws, incorporated in the Bankruptcy Code by 11 U.S.C. § 522, exempt from property of the estate certain property, including equity in real property, subject to dollar limitations.[3] Several courts have opined on whether the debtor’s exemption applies to funds generated from a lien holder’s carveout for the sale of property. The apparent majority of cases have ruled that the debtor’s
exemption does not attach to such proceeds which inure to the estate by virtue of the secured lender’s carveout.[4] The secured lender, it is reasoned, can distribute the proceeds subject to its lien as it deems fit, including by transferring such carveout funds to the bankruptcy estate. In re Wilson, a Central District of California Bankruptcy Court case, appears to be an outlier, ruling that it makes no difference that the funds collected by the trustee amount to a “tip” from the secured lender—the proceeds of the sale constitute property subject to the debtor’s homestead exemption.[5] However, in light of the weight of cases contrary to
Wilson, carveouts are sure to remain a fixture in bankruptcy estate liquidations, whether they are of the debtor’s homestead or of investment properties that would not be subject to the debtor’s exemption.

INTRODUCTION
In the series of articles published
Inforuptcy's blog, readers have learned investment opportunities exist within the bankruptcy court. For example, the bankruptcy court can provide a venue for distressed securities investors to purchase and work with debtors to provide mutually beneficial outcomes.

Building on the above, how does an investor, who would like to purchase a distressed asset through the bankruptcy court, make a sound investment and potentially recover the costs of an unsuccessful bid?

An investor can make an offer to purchase an asset or company through the bankruptcy court by making a stalking horse bid. In the event that bid is not the winning bid, then the investor may request a breakup fee. Distressed companies may welcome a stalking horse bid because they know there is a buyer willing to pay a minimum bid, and that bid may prompt other investors to make better offers.

EXAMPLE
Consider a situation where Jimbo’s Gym is insolvent because of a large lawsuit and is forced to file for Ch. 11. Assume Jimbo (“the Debtor”) is in control of the bankruptcy estate (Please note: certain creditors may have influence over a debtor’s decisions). Jimbo has hired analysts who have valued Jimbo’s Gym at $2.5 million.

Billy Buyer negotiates with Jimbo an asset purchase agreement whereby
Billy Buyer will purchase Jimbo’s Gym’s assets in exchange for $2 million cash ̵#8211; this is the stalking horse bid. Billy Buyer knows he is offering to buy the assets for Jimbo’s Gym at a discount and may be outbid prior to the confirmation of the asset purchase agreement. As a preemptive measure, Billy Buyer has included a clause in the asset purchase agreement whereby if he is outbid, he, with the approval of the bankruptcy court, will be allowed to recoup his investment investigation or due diligence costs, and some of the time he spent (this is the breakup fee). The Debtor knows he may have entered into an asset purchase agreement whereby Billy Buyer may be able to purchase the assets of Jimbo’s Gym at a discount, but believes the opening bid of $2 million will attract other buyers that may make a better offer.

One of two things can happen: (1) there is no other bid and Billy Buyer wins, or (2) there is another bid and Billy Buyer loses.

1. There is no other bid.

If there is no other bid, Billy Buyer will receive all of the assets of Jimbo’s Gym for $2 million.

2. There is another bid.

Millionaire Max, at the same time Billy Buyer noticed that Jimbo’s Gym had filed Ch. 11, also subscribes to Inforuptcy and noticed Jimbo’s Gym had filed Ch. 11. Millionaire Max believes $2.5 million is a steal and will not hesitate to pay that amount. Millionaire Max offers $2.5 million and, accordingly, the offer is accepted.

Billy Buyer, who has spent $60,000 thus far, has lost and now wants to recoup his breakup fee. The bankruptcy court agrees Billy Buyer’s bid prompted Millionaire Max to pay the full price, and therefore, benefited the estate and agrees to allow Billy Buyer recover his due diligence costs and a reasonable breakup fee.

MIXED OFFERS
Assume that instead of offering cash, Millionaire Max offers a combination of cash and stock. The combination of cash and stock from Millionaire Max must be compared the all-cash offer from Billy Buyer. If Jimbo believes the combination of stock and cash from Millionaire Max is worth more than Billy Buyer’s all-cash offer, then he should still accept Millionaire Max’s offer over Billy Buyer’s.

CONCLUSION
In conclusion, there may be opportunities within the bankruptcy court should investors monitor the bankruptcy filings using tools like those provided through Inforuptcy.

__________________________________

To use the only search tool to find bankruptcy asset sales across the country, you can sign up to our Maverick plan for $99
/ month (cancel any time).

If you are a real estate investor interested in short sale leads from dismissed chapter 13 cases, you can sign up
to our new reports plan for $49 / month (cancel any time).

If you prefer, you can also schedule a 15 minute web demo so you can see for yourself how to get started.